462 Chapter 5 Notes 2019

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CONSOLIDATION SUBSEQUENT TO ACQUISITION DATE

Learning Objectives
o Consolidate a non-wholly owned subsidiary in years subsequent to acquisition, including
consolidation of the income statement and statement of retained earnings.
o Apply the amortization of the acquisition differential.
o Eliminate simple intercompany transactions
o Explain and account for a consolidation where the parent has used the equity method to
account for the investment.
IMPORTANT: In this chapter we have two slight deviations in the application of the consolidation
steps from the text book. You can choose which methodology to use, however all examples,
solutions and future chapters will be based on the methodology described in these notes
Recap – Where we have been and where we are headed (summary, not in text)
 In Chapter 3, we learned how to consolidate a 100% owned subsidiary
 In Chapter 4, we learned how to consolidate a subsidiary that was not 100% owned, it had a
“non-controlling interest,” or NCI. Ie – it had other minority owners, other than the parent
company.
 In both chapters, we assumed consolidated statements were being prepared right after
acquisition. Consequently:
o We did not do an income statement, as there would be no transactions that had occurred
since the parent bought the sub. We eliminated the entire R/E of the sub when
consolidating. The parent will only share in the sub’s income and retained earnings for
the period from acquisition forward.
o There were no changes to the assets and liabilities of the sub from the time of acquisition
to the time of consolidation. We only had to adjust them to market value at acquisition.
Chapter 5 now looks at consolidating a parent and subsidiary later on (for example, one or
more years after acquisition). When we consolidate after acquisition, we have to consolidate the
income statement of the sub with the parent income statement.
Remember in the Chapter 2 notes, we dealt with the equity method. Under the equity method, the
net income of the associate is recorded, on a proportional basis, in the books of the acquirer.
However, there were complications we dealt with.
 When there was an acquisition differential, it created three potential adjustments:
o Goodwill impairment could affect the net income of the associate recorded by the investor.
o The difference between fair values and book value of depreciable and non-depreciable
assets at acquisition affected the net income recorded by the investor from the associate.
 We had to adjust the net income of the associate by depreciation of the fair value
differences on depreciable assets such as plant and equipment,
 We had to adjust the net income of the associate by the fair value difference when a
non-depreciable asset was sold, essentially adjusting gain or loss on sale.
 In addition, we had to examine intercompany transactions, such as the sale of inventory. We
had to eliminate any intercompany unrealized profits that were still in inventory (that is, any
inventory that had not yet been sold to a third party).
Forms for text problems: Copyright  2019 McGraw-Hill Ryerson Limited. All rights reserved
These same items will affect consolidated net income – before the parent can combine the
subs net income with its own, it has to take these items (and others ) into consideration. We will
deal with the issues associated with the above in chapters 5, 6, and 7.
In Chapter 3 and Chapter 4, when we purchased the subsidiary, we took the purchase price or
implied valued and then we allocated it:
 First to the book value of the sub’s net assets (this gave us the Acquisition Differential, which is
the difference between the purchase/implied value and the book value of the sub’s net assets)
 the difference between market and book values (fair value differentials)
 and the remainder to Goodwill.
This will always be our starting point in a consolidation. However, now in Chapter 5, when we
consolidate several years later, we have to take into consideration “amortization of the
acquisition differential.” What this means is we have to consider how the original fair value
differentials and goodwill (which you recall adds up to the AD) will be changed over time, by the
following items….notice how the below is a similar concept to what was described from chapter 2:
 Any goodwill impairment: We record goodwill at acquisition on the consolidated balance
sheet. Ongoing, this goodwill could become impaired, this would mean writing down the
goodwill in the consolidated income statement and balance sheet.
 Adjustments to consolidated depreciation expense: When the subsidiary depreciates its
depreciable assets, it is still using the carrying value, because that is what is on the sub’s
books and records. When we consolidate, we have taken into consideration that the fair value
of plant and equipment at acquisition may have been higher or lower, in chapter 4 we adjusted
the sub’s depreciable assets on the consolidated statement to fair value at acquisition. This
also means that ongoing we need to adjust consolidated depreciation, basing it instead on
the fair values we have recorded, essentially depreciating the fair value difference.
 Adjustments to consolidated gain or loss on sale of non-depreciable assets: When the
subsidiary sells an asset such as land, it is recording a gain or loss on sale based on the
carrying value on its books. On the consolidated books and records, in chapter 4 you learned
that we have adjusted the sub’s non-depreciable assets to fair value at acquisition. So, when
the sub then sells the asset, this affects the gain or loss recorded in the consolidated
income statement. When a non-depreciable asset is sold, we essentially need to derecognize
the fair value difference by adjusting the gain/loss on sale.
 Adjustments to gross profit due to sale of inventory: Remember that inventory is a non-
depreciable asset. When the subsidiary sells its inventory, it records cost of sales based on the
carrying value. However, in chapter 4 you learned that on the consolidated statement we will
have adjusted the sub’s inventory to fair value at acquisition. So, when the sub then sells this
inventory, this affects cost of sales and gross profit recorded in the consolidated income
statement. When inventory is sold, we essentially need to adjust COGS for the fair value
difference, derecognizing the difference.
All of these things, and others, can cause amortization of the acquisition differential – meaning
this differential is changing over time – usually declining.
Ok! So let’s get started….
Methods of Accounting for an Investment in a Subsidiary (207-209)
 Read this section carefully. It outlines the methods of accounting for a subsidiary, and the
impact each of these methods has on the preparation of consolidated financial statements after
the acquisition date.
 Remember, consolidation occurs at year-end, consolidation working papers contain the
adjustments, these are not made in either the parent or sub’s books and records.
 The parent then still has to have a method to account for the sub in its books and records
ongoing. The parent can choose to account for a subsidiary in their own books and records
using two methods:
The cost method
 Investment is recorded at the cost at acquisition
 Dividends are recorded when received or receivable from the subsidiary as
income
 If the investment in the sub were to become impaired, this would be recorded
 This is the quickest method of recording an investment and is the most often
used, but requires the most adjustment at consolidation.
The equity method – (similar to using the equity method for significant influence)
 Investment is recorded at cost at acquisition
 Dividends are recorded as a reduction to the investment account
 The parent records a proportional amount of the sub’s net income as an increase
to the investment account (after adjusting for differences in depreciation, gains and losses
on asset sales, intercompany transactions, etc. similar to chapter 2)
 If the parent uses the equity method, then the consolidated net income would
actually be equal to the net income the parent reports in its own statements under the
equity method, because all of the adjustments we discuss above would have occurred as
part of its equity method entries. The consolidated retained earnings will be the same as
the parent’s retained earnings under the equity method.
 So, some of the work in terms of the adjustments needed to retained earnings is
already done if the parent uses the equity method in their own books and records, however
we still have to consolidate the statements and make sure the adjustments are recorded in
the specific consolidated accounts on a line by line basis.
Note we focus on the cost method, since it is more commonly used, with only the
occasional question taking into consideration the equity method. We will do a problem with
the equity method at the end of chapter 5.
Consolidated Income and Retained Earnings Statements (209-211)

 Read this section carefully, more than once.
Consolidated Income Statement: A consolidated income statement will be prepared,

combining the income statements of the parent and the sub for the current year on a line by line
basis. However, the consolidated income statement must be adjusted for:
1. Current years amortization of acquisition differential (discussed on page 2), in summary:
a) If the fair value of plant and equipment at acquisition was higher or lower than the
subsidiary’s carrying value, we need to adjust consolidated depreciation expense.
b) If goodwill is recorded at acquisition, it could become impaired, so then we need to record
a loss on goodwill in the consolidated income statement.
c) If the fair value of non-depreciable assets such as land at acquisition was higher or lower
than the subsidiary’s carrying value, we need to adjust consolidated gain or loss in the
year when it is sold.
d) If the fair value of inventory at acquisition was higher or lower than the subsidiary’s
carrying value, we need to adjust consolidated cost of goods sold/gross profit when
sold.
2. Intercompany transactions, which include three different types:
e) Intercompany dividends, these need to be eliminated from the sub’s statement of retained
earnings and the parent’s income.
f) Intercompany transactions that net to zero, such as rent, management fees, intercompany
interest on loans (these items will have revenue in one company and an expense in the
other for the same amount). This will also include balance sheet items such as
intercompany payables/receivables. These items do not affect profits or net assets, but
get eliminated to ensure individual accounts such as revenues and expenses, payables
and receivables are not overstated.
g) Intercompany profits – When there is a sale of inventory or assets between the parent and
sub, and the asset or inventory has not been sold to an outside party, there are unrealized
profits that must be eliminated. This will be dealt with in Chapters 6 and 7.
3. If there is an NCI (non-controlling interest, ie other shareholders other than parent), the
amount of non-controlling interest in income is calculated, and deducted near the end of
the statement. We will refer to this as INCI (NCI on the income statement).
So, similar to the balance sheet consolidation we have done, the two income statements are
added together, adjusted for #1 and #2 above, and the NCI portion of income is shown as one line
item. This basically divides net income into net income of the parent and net income of the NCI.
Consolidated retained earnings: When we consolidate, the parent’s retained earnings is kept,
and the sub’s retained earnings at acquisition is eliminated. However, from the point of
acquisition forward, the consolidated retained earnings will include the parent’s % portion of the
sub’s r/e earned since acquisition (similar to NI, however it must be adjusted for the amortization
of the AD).
When the parent uses the cost method, the parent’s opening retained earnings:
 will include the effect of past dividend income from the sub (an intercompany trx)
 will not include the effect of the parent’s share of the sub’s income, and
 will not include the effect of any acquisition differential amortization.
Adjustments must be made to correct these differences in order to arrive at consolidated opening
retained earnings.
Seem complicated? It is, but we will give you a methodical process to follow that will help
you capture all of the above, read on!
Testing Goodwill and Other Assets for Impairment (211 – 218)
Read this section for review, recall from Intermediate Accounting that goodwill and other
intangibles must be tested annually for impairment, and written down if necessary.
Consolidation of a 100-Percent-Owned Subsidiary (218 – 227)

Go over the this example first. In the examples in these notes, we will go directly to consolidating
a non-wholly owned subsidiary (so one with NCI).
Consolidation of an 80-Percent-Owned Subsidiary ((227 – 238))

The text examples are good examples of how consolidation is carried out, and should be studied
for an understanding of the topic. Go over these examples in the text. We will lay them out slightly
differently, but it is helpful if you understand the basic principles. Below are some key points:
Acquisition:
 The sub is acquired as of January 1, Year 5. This is time zero (acquisition).
 On page 228 (top) note the investment is recorded at cost.
 On page 228 (bottom) the acquisition differential is calculated ($3,000) and is allocated to
fair values less book values ($2,000) and goodwill ($1,000). Also on p 228 (middle), a
consolidation at acquisition has been prepared doing the same method as we would have in
chapter 4. Nothing different here.
Consolidation one year later (It is labelled as the end of Year 5 in the text):
 On page 229, they start a consolidation 1 year after acquisition. During the year, dividends
were recorded using the cost method by the parent.
o These dividends will be eliminated in the consolidated statements
 Note on page 229 and 230, the income statement, statement of r/e, and b/s are provided for
each of the parent and sub, at the end of the year.
 Note on page 230 (exhibit 5.11), a changes to acquisition differential has been recorded for
the end of Year 5 (using the goodwill and inventory calculated at acquisition). This is an
important step that we will be doing each time we consolidate. It shows the change in the
acquisition differential since acquisition based on the balance sheet changes.
 THIS IS THE FIRST DIFFERENCE BETWEEN THE TEXT AND NOTES
Changes to the acquisition differential schedule (similar to Exhibit 5.4)

Balance Jan Changes in Balance Dec
1, yr 5 yr 5 31, yr 5
Inventory 2,000 (2,000) -
Goodwill 1,000 (50) 950
Total 3,000 (2,050) 950
o The text focuses on how changes impact the balance sheet accounts. The changes
described show if the balance sheet account is increasing or decreasing in the year. In
this case, the inventory was sold and the goodwill was written down.
o Using this schedule may require you to adjust sign of the changes column in subsequent
schedules when determining income statement and retained earnings balances.
o The balance at the end of the year is simply adding the opening balance to the change.
 Instead we will be using a slightly different schedule called, “acquisition differential

amortization and impairment” schedule. There are two distinct advantages with this approach
advantage:
1. We will be describing balances as Debits and Credits by showing debits as positives and
credits as negatives. This may seem like a minor issue but you will find, by following this
convention throughout all future schedules, it will make the consolidation process easier.
2. Changes will not describe the impact to the balance sheet but instead will describe the
income impacts (current and prior year).
Acquisition differential amortization and impairment schedule

DR / (CR) FVD (Bal) Jan Amort & RAD Balance
1, yr 5 impair, yr 5 Dec 31, yr 5
Inventory 2,000 2,000 -
Goodwill 1,000 50 950
Total 3,000 2,050 950
o The amortization and impairment column describes the impact to the income statement
due to the FVD (fair value differential) upon acquisition. So we have two debits to the
income statement (increase in CoGS as a result of the sale of inventory and increase in
the write down of goodwill due to impairment). These adjustments to the i/s are shown
above in yellow.
o The balance at the end of the year (referred to as remaining acquisition differential (or
RAD)) is simply subtracting the amortization & impairment column (I/S impact) from the
opening balance. These adjustments in blue, reflect the remaining AD and will need to be
made to the b/s.
 Please note whichever schedule you decide to use, you will end up at the same ending
balance for the balance sheet accounts at the end of the year.
Irrespective of which schedule you use, the following explains how the activity in the year is
determined
 The inventory that existed at acquisition is now sold, we will no longer adjust sub’s inventory
to fair value at acquisition on the consolidated b/s since it is now sold. However, we will record
a $2,000 debit to cost of goods sold, to reflect that our fair value was $2,000 higher than the
subsidiaries carrying value. Page 231 shows the consolidated i/s, you can see the $2,000
adjustment.
 There is a $50 goodwill impairment. So, when we record the goodwill on the consolidated
b/s at the end of the first year, we will no longer record it at $1,000, but instead $950. In
addition, we will need to record a $50 impairment loss in the consolidated i/s. Again, you can
see this adjustment in the consolidated i/s on page 231. You can see Goodwill on the
consolidated b/s is $950 on page 232, not $1,000.
 On page 231(top), consolidated net income is calculated. This is a check figure, when we
consolidate the income statement, this is what we should get. Note also that INCI (net income
attributable to the NCI) has been calculated, and appears on the consolidated i/s on page 231.
 Also note in the calculation of consolidated income statement on page 231 that the dividend
income from the sub to the parent, which appears on the Company P income statement on
page 229, has been removed (it is an intercompany transaction).
 On page 232, BNCI is calculated as $4,350 and is on the consolidated b/s on page 232.
 In the statement of retained earnings on page 249, consolidated retained earnings is
calculated using the parent’s opening balance, plus consolidated net income, less the
dividends declared by the parent only. The dividends declared by the sub are eliminated
 Note also on the consolidated balance sheet, at the bottom of page 232 that the investment
in S account has been removed, as well as the common shares of the sub (again, similar to
ch. 4)
Consolidation at the end of of the second year of ownership: (It is labelled as the end of Year
6 in the text). We go through many of the similar steps:
 During the second year of ownership, dividends were recorded, using the cost method, by
the parent.
o These dividends will be eliminated in the consolidated statements. Note that they
have been removed in the consolidated i/s on page 236.
 The acquisition differential schedule has been updated to the end of the second year (page
234)
o The inventory was sold last year, as noted above, no fair value adjustment is done on the
consolidated b/s. However, the $2,000 adjustment to COGS done last year, must be
redone this year. However, it will now be done through consolidated R/E (this should
make sense, last year’s COGS is in sub’s R/E, so any adjustments to it need to go through
consolidated R/E as well.) In the middle of page 235 is a rather complicated looking
calculation of consolidated r/e. Note that there is an adjustment for the “Acquisition
differential amortization and impairment to end of Year 5,” for $2,050. $2,000 of it is
the COGS adjustment from last year’s sale of inventory.
o The goodwill was impaired last year by $50. It is impaired this year by $80. This will have
three implications:
 When we record the goodwill on the consolidated b/s at the end of the second year,
we will no longer record it at $1,000, but instead $870, see the b/s on page 236.
 Similar to inventory discussed above, the prior year’s impairment of $50 will now
have to be recorded in consolidated r/e, this is done as part of the $2,050 adjustment
in the calculation on page 235 of consolidated R/E.
 The current year’s impairment loss of $80 must be recorded in the current year’s
consolidated i/s, which you can see on page 236 (top).
 Once again, at the top of page 235, consolidated net income is calculated, a portion is
attributed to INCI.
 In the middle of page 235, you will notice that complex calculation of opening consolidated
r/e. Notice that the balance of $101,500 is the same as the closing consolidated r/e reported
on page 232 (end of the first year). We will do a similar calculation, it allows us to figure out
consolidated r/e several years down the road, without having to redo the statement of r/e every
year.
 On page 235, BNCI is calculated as $5,734 and is on the consolidated b/s on page 236.
 Note also on the consolidated balance sheet, on page 236 that the investment in S account
has been removed, as well as the common shares of the sub (again, similar to chapter 4)
Summary of Steps that we will use in class (not in text):

 THIS IS THE SECOND DIFFERENCE BETWEEN THE TEXT AND NOTES
o You will note in steps 4-6, example on page 235, the text ignores any debit/credit
conventions instead uses the normal balance convention. If you recall from introductory
accounting a normal balance for an account is the side of the account that leads to
increases. (example, net income – credits increase balance).
o In the notes, we will continue to follow the Debit / Credit convention where debits are
shown as a positive and credits are negative.
o Please note when performing step 7, when you complete the worksheet, we will transition
from debit/credit convention to normal balance convention.
Step 1: At the purchase date, use the Acquisition Differential Schedule to allocate the purchase
price to the book value and market values of the sub’s net assets, calculate goodwill (no
different from chapter 4).
Step 2: Prepare the Acquisition differential amortization and impairment schedule from the
purchase date to the current date.
Step 3: Eliminate intercompany transactions. In this chapter, it could include:
 Dividends from the sub to the parent
 Interest or management fees paid between the companies
 Intercompany payables/receivables from management fees or interest
Step 4: Calculate non-controlling interest for the balance sheet and income statement (BNCI
and INCI).
Step 5: Calculate consolidated net income. This calculation is not strictly required in the
preparation of consolidated financial statements, but it is a valuable check; and many
questions, including examination questions, specifically ask for it.
Step 6: Calculate consolidated opening retained earnings.
Step 7: Consolidate - Apply the adjustments identified in the previous steps in the preparation of
consolidated financial statements.
Additional explanation of steps:
Step 2: For Step 2, we will use the following table to prepare the acquisition differential
amortization and impairment schedule. This uses the data from the text example for Year 6
(second year after acquisition).
FVD (Bal) Amort & UAD Balance Amort & RAD

Jan 1, yr 5 impair, yr 5 Dec 31, yr 5 impair, yr 6 (Balance)
Dec 31, yr 6
Inventory 2,000 2,000 - - -
Goodwill 1,000 50 950 80 870
Total 3,000 2,050 950 80 870
SORE SANI SANA
The FVD (fair value differential) column is from the acquisition differential table calculated at
acquisition.
 Recall that in Year 5, the inventory that had been on the sub’s books at acquisition was
sold, so we had to adjust COGS for $2,000. Now that the inventory is sold, the FVD is zero,
as we will no longer need to adjust it to fair value.
 Also in Year 5, there was a $50 impairment to goodwill, so at the end of the year, the FVD
that is “left” for goodwill is $950.
 In year 6, there was an additional $80 impairment, so the FVD for goodwill is now $870.
 The total of all remaining FVD will now be referred to as the RAD, or remaining acquisition
differential. At acquisition, our AD was $3,000. At the end of Year 6, the UAD is $870. Our
acquisition differential has been “amortized.”
Color Coding:
o Because both Year 5 adjustments affect opening R/E, we have labelled the total SORE, sub’s
opening R/E. We will use it to calculate opening consolidated r/e. Use a green highlighter for
SORE adjustments.
o The $80 impairment loss affects the current years consolidated income statement (shown in
yellow as an income statement adjustment).
o The $80 is also the current years amortization of the AD, it affects our calculation of the INCI,
we use it to determine SANI, which stands for sub’s adjusted net income.
o At year end, we will still need to adjust consolidated Goodwill to $870. This is shown in blue
as a balance sheet adjustment. This now replaces the adjustment at acquisition for $1,000.
o The total RAD at the end of Year 6 is also $870. It will also affect the sub’s adjusted net assets
so we label it (SANA), which we will use to calculate BNCI.
Step 4: we will use the following to calculate BNCI and NCI:

BNCI (NCI on the BS):
Sub’s BV of net assets, end of current year
Common Shares xx **
R/E xx **
Add/subtract RAD xx
=Sub’s adjusted net assets (SANA) xx
NCI % share of ownership x%
BNCI (appears in equity section of the consolidated BS) (xx) Note we flip the sign CR
** (note: these balances are shown as debit because we are describing net assets)
INCI:
Sub’s net income (current year) (xx)
Add/subtract Current year Amortization of RAD xx
sub’s adjusted NI (SANI) (xx)
NCI % share x%
INCI (appears on the consolidated IS) XX Note we flip the sign Dr.
Step 5: we will use the following to calculate the parent’s share of consolidated NI:
This calculation is not strictly required in the preparation of consolidated financial statements, but it
is a valuable check; and many questions, including examination questions, specifically ask for it.
Calculate consolidated NI
Parent’s NI; cost method (xx)
Eliminate dividend income from subsidiary (Step 3) xx
Parent’s adjusted net income (PANI) (xx)
Plus sub’s adjusted NI (SANI from Step 4) (xx)
X parent’s % ownership x% (xx)
Parent share of consolidated net income (xx)
Step 6: we will use the following to calculate the parent’s opening, consolidated R/E.
Parent’s RE at the beginning of the current year (xx)
Sub’s RE at the beginning of the current year (xx)
Less: Sub’s RE at acquisition date (xx)
Increase since acquisition (xx)
Add/subtract acquisition differential amortization and impairment to end
of previous year xx
Balance (SORE) (xx)
Parent’s ownership x % owned (xx)
Consolidated RE beginning: (xx)
Less Opening R/E (both sub and parent added) (xx)

Elimination Adjustment in statement of r/e xx
Step 7: Consolidation:
o Start by eliminating the Investment in sub account and the common shares of the sub
o Go through each step and do adjustments to R/E, BS, IS.
o Calculate consolidated NI first.
o Calculate consolidated R/E next. Note the consolidated NI needs to then flow into the
consolidated statement of R/E.
o Consolidate the b/s last. Closing R/E from the consolidated statement of R/E then needs to go
into the consolidated B/S.
o When consolidating, do not add across any totals or subtotals. The consolidation
column should always be subtotaled and totaled from top to bottom.
An important note on the above schedules and steps: The steps above seem confusing at first
– there is a lot to remember. One of the challenges of consolidation after acquisition is that we
have to capture changes to the acquisition differential from acquisition to the date of consolidation,
as assets/liabilities are amortized, sold, or impaired. These changes will affect the balance sheet,
retained earnings, BNCI and current year’s net income. In essence, we could do individual entries
for every change. However, the above calculations allow us to summarize the changes and do
cumulative adjustments instead.
The schedules above need to be memorized for exams, however we will use them a lot in
examples and in homework, so you will get used to them. Remember, do every
consolidation available to you as practice. Try not to look at the solutions when you
practice to force yourself to memorize the process.
Abbreviation Summary of above:

 INCI (NCI on the IS) This will be calculated and will appear on the i/s
 BNCI (NCI on the B/S) This will be calculated and will appear on the b/s
 SANA (sub’s adjusted net assets) This will be used to calculate BNCI above.
 SANI (sub’s adjusted NI) This will be used to calculate INCI and consolidated NI
 PANI (parent adjusted NI) This will be used to calculate consolidated NI
 SORE, (sub’s opening RE) This will be used to calculate consolidated RE
Color Coding summary: Highlight colors will be:

Blue for BS adjustments, these will be used directly in the consolidated BS
Yellow for IS adjustments, these will be used directly in the consolidated IS
Red (pink for you) for RE adjustment and consolidated R/E
Green for adjustments that transfer to other schedules, ie. calculating SANI , SANA,
PANI (parent’s adjusted NI), SORE and PORE (parent’s opening retained earnings)
It is highly recommended you buy the highlighters and utilize them for examples, homework and
on exams. The colours will help you categorize and track key pieces of information.
Identifiable Net Assets Method (237-238)

 Calculated similar to chapter 4.
Acquisition Differential Assigned to Liabilities (238 – 240)

 The first couple of paragraphs of this section describe the basic concept, which is really what
you need to know. The rest is a review from Intermediate Accounting of using the effective
interest method. For the problems that you do, any difference between book value and fair
value of liabilities will be amortized straight-line for simplicity, or you will be given the amount
to amortize it by (you will not have to figure out effective interest).
Intercompany Receivables and Payables (240)

 Since the consolidated entity cannot lend or borrow from itself, any receivables and payables
between the parent and the sub must be eliminated. This was noted in the discussion above.
Example 1: Using the information from Problem 5-2 (282) ignore the list of requirements in the text
and instead perform the calculations for Steps 1 – 7 above to consolidate at Year 8. Use the
worksheet on the next page for the financial statements and step 7. Notes for example:
 When there is a fair value differential for a current asset or liability, it is assumed to be fully
amortized in the first year, as the item is current and should be settled in that time (unless we
are told otherwise). So, items like inventory, are assumed to be sold.
 A fair value differential for a depreciable asset will be depreciated on the same basis as the
underlying asset, so use the same depreciation period and method as the sub uses for that
asset.
Example 1: Problem 5-2
Income Statement Large Small Adjustments Consolidated
1,620,00
Sales 0 283,000
1,152,00
COGS 0 130,000
Gross profit 468,000 153,000
Int & div income 50,000 2,000
Total income 518,000 155,000
Depreciation exp 50,000 15,000
Other exp 108,000 34,000

Net income 360,000 106,000

Retained Earnings
Opening 660,000 286,000
Net income 360,000 106,000
Dividends 54,000 56,000
Closing 966,000 336,000

Balance sheet
Current assets 208,000 460,000
Cap assets – net 668,000 558,000
Other investments 60,000 20,000
Investment in Small 770,000
Intangible assets 70,000

1,706,00
Total assets 0 1,108,000

Current liabilities 90,000 112,000
Notes pbl 130,000 100,000
Common stock 520,000 560,000
RE 966,000 336,000

1,706,00
Total liab & equity 0 1,108,000
After reviewing Example 1, you can complete the following questions (make sure to review
changes described in the assignment summary section):
 Problem 5-7 (hand in)
 Problem 5-5
 Problem 5-12
 Problem 5-15
A note regarding accumulated depreciation at the purchase date
Some problems tell us the amount of accumulated depreciation on the sub’s books at the purchase
date. In these cases it is necessary to remove the amount of the accumulated depreciation from
both the cost of the related asset and its accumulated depreciation in the process of consolidation.
Here’s why.
Suppose that Pco purchased a controlling interest in the shares of Sco, and that on the date of
purchase, the financial statements of the two companies included:
Pco Sco
Equipment 20,000 10,000
Accumulated depreciation 9,000 3,000
Suppose also that the fair value of Sco’s equipment was $8,000. Since the book value of Sco’s
equipment is $7,000, the FVD would be $1,000.
When we prepared the consolidated financial statements on this date, we might go:
Pco Sco Adjustment Consolidated
Equipment 20,00 10,00 1,000 31,000
0 0
Accumulated depreciation 9,000 3,000 12,000
However, Sco’s equipment is supposed to be consolidated at its fair value of $8,000, so that the
consolidated value for equipment should be 20,000 + 8,000 = 28,000.
If we remove Sco’s accumulated depreciation amount from both accounts, we get:
Pco Sco Adjustments Consolidated
Equipment 20,000 10,00 1,00 (3,000 28,000
0 0 )
Accumulated 9,000 3,000 (3,000 9,000
depreciation )
This achieves the goal of having Sco’s equipment being at its fair value of $28,000. Either way the
consolidated net book value is $19,000, so no imbalance results, but the second way achieves the
result of having Sco’s equipment recorded at fair value.
This same adjustment to remove the amount of opening accumulated depreciation must be done
each year in the future as well.
Bottom line: If a problem gives the capital assets as a net figure, or if it does not provide
information about the accumulated depreciation at the purchase date, the above issue may be
ignored. If you are given the figure for the sub’s accumulated depreciation at acquisition, you need
to eliminate it using the above method.
If accumulated depreciation is shown separately on the worksheet, in the AD amortization and
impairment schedule, you need show accumulated depreciation of the fair value of difference on a
separate line, this is shown in example 2.
Example 2: Problem 5-10 (289) Part (a) only. Include all 7 steps above, using the worksheet form
on the next page to consolidate (step 7). Impairment losses are to be shown separately rather
than in Other Expenses. The text shows capital assets net; the worksheet form has this broken
down into cost and accumulated depreciation in accordance with GAAP. In addition, the
worksheet has relabeled “selling expenses” to “depreciation & amortization expense”. Assume
that Storm’s accumulated depreciation at the purchase date was $25,000.
Example 2: Problem 5-10
Income Statement Palm Storm Adjustments Consolidated
Sales 910,000 555,000
COGS 658,000 380,000
Gross profit 252,000 175,000
Int & div income 38,000 6,000
Total income 290,000 181,000
Depr. & amort.
expense 26,000 39,000
Other expenses 156,000 80,000
Impairment loss
Net income – entity
NCI
Net income 108,000 62,000

Retained Earnings
Opening 82,000 152,000
Net income 108,000 62,000
Dividends 40,000 24,000
Closing 150,000 190,000

Balance sheet
Cash 24,000 34,000
A/R 92,000 180,000
Notes rcbl 14,000
Inventory 140,000 220,000
Plant assets 540,000 260,000
(270,000 (60,000
Accum depr ) )
Other investments 86,000 26,000
Investment in Storm 350,000
Trademark
Goodwill
Total assets 962,000 674,000

Accts payable 108,000 70,000
Other curr liab 14,000 54,000
Notes pbl 150,000 120,000
NCI .
Common stock 540,000 240,000
RE 150,000 190,000
Total liab & equity 962,000 674,000
Example 3: Problem 5-14 (294). Include all 7 steps above. Note that on the worksheet, we have
replaced distribution expense with depreciation expense.
Income
Statement Albeniz Bach Adjustments Consolidated
Sales 600,000 400,000
Interest income 6,700
Dividend income 6,400
Total revenues 613,100 400,000
COGS 334,000 225,000
Depreciation exp 20,000 70,000
Sell & admin exp 207,000 74,000
Interest exp 1,700 6,000
Inc tax exp 20,700 7,500

Net income 29,700 17,500
Retained
Earnings
Opening 140,300 154,000
Net income 29,700 17,500
Dividends - 8,000
Closing 170,000 163,500
Balance sheet
Cash 40,000 21,000
Receivables 92,000 84,000
Inventories 56,000 45,000
Land 20,000 60,000
Plant & equip 200,000 700,000
(80,000 (350,000
Accum. Depr ) )
Investment in
Bach 272,000
Advances to
Bach 100,000

Total assets 700,000 560,000
Accts payable 130,000 96,500

Advances
payable 100,000

Common stock 400,000 200,000
Retained
earnings 170,000 163,500
Total liab & equity 700,000 560,000
changes described in the assignment section):
 Problem 5-9 part a (hand in)
Subsidiary Acquired during the Year (240, 241)

If the purchase of the subsidiary occurred partway through the year, the amounts of income and
depreciation are pro-rated for the number of months the parent had control of the sub. This will
affect the first year after consolidation in Step 2. Our examples will generally assume full-year
consolidation, unless otherwise specified.
Equity Method of Recording (241 – 244)

Read this section and be aware that if the parent has used the equity method to account for the
investment in the sub, the consolidation process is simplified, as many of the adjustments have
already occurred. The basic differences are:
 The parent’s financial statements are different than they would be if the cost method had been
used:
o The Investment in Subsidiary account will have a different balance from at
acquisition. Under the equity method, the investment is originally recorded at cost but
over time it is increased to reflect the parent’s share of the subsidiary’s adjusted net
income, and reduced to reflect the parent’s share of the subsidiary’s dividends.
o Under the cost method, investment income from the subsidiary will consist of
dividends received. Under the equity method, investment income from the subsidiary is
the parent’s share of the subsidiary’s adjusted net income.
o Current year opening retained earnings will be different under the equity method, as
it will include the past effects of adjusted equity method income from the sub.
The changes to how we consolidate will be:
 There is no need to eliminate dividends received from the subsidiary from income in Step 3, as
they will have been recorded as a reduction of the investment account. However, instead we
will have eliminate the investment income that has been recorded using the equity method.
 Consolidated net income will be the same as the parent’s net income, so Step 5 is not needed.
 Consolidated opening retained earnings will be the same as the parent’s opening retained
earnings, so Step 6 is not needed.
Example 4: Problem 5-15 (295) Include the Year 3 journal entries that Brady would have made to
account for its investment in Partridge. Note, text refers to financial statements being provided on
the following page. The text did not provide the statements. Use the form on the next page.
changes described in the assignment section):
 Debrief analysis (hand-in, see below for instructions)
Analysis and Interpretation of Financial Statements (244 – 246)

 Read for interest only.
ASPE Differences (247)
 Read for interest only. Recall that private companies may use the cost method, the equity
method, or fair value to record investments in subsidiaries.
Example 4: Problem 5-15 (Equity Method)
Income Statement Brady Partridge Adjustments Consolidated
Sales 10,100,000 5,100,000
COGS 7,022,000 3,030,000
Gross profit 3,078,000 2,070,000
Equity method inc 136,000
Total income 3,214,000 2,070,000
Depr exp 920,000 402,000
Patent amort exp 120,000
Interest exp 490,000 310,000
Other exp 700,000 870,000
Tax exp 620,000 160,000
GW impairment
NI – entity
NCI
Net income 484,000 208,000

Retained Earnings
Opening 6,198,000 3,181,000
Net income 484,000 208,000
Dividends 300,000 110,000
Closing 6,382,000 3,279,000

Balance sheet
Cash 420,000 620,000
A/R 1,100,000 1,400,000
Inventory 4,800,000 2,000,000
Plant & equip 8,200,000 5,200,000
Patents 720,000
Inv. In P shares 4,584,000
Goodwill
Total assets 19,104,000 9,940,000

Accts payable 3,522,000 1,540,000
Bonds payable 4,100,000 3,100,000
NCI
Common stock 5,100,000 2,021,000
RE 6,382,000 3,279,000
Total liab & equity 19,104,000 9,940,000
Buad 462 Chapter 5 Forms Page 19 of 23
Assignment summary:
 Problem 5-7 (285) (Cost Method). Form provided. Ignore the information about the price of
Lee shares at the purchase date. On the form, distribution expense has been renamed to
depreciation expense. Record impairment losses as a separate line item. (hand in)
 Problem 5-9 Part (a) only (288) (Cost Method). No form provided; prepare all adjustments as
usual and combine them line-by-line with the financial statements of the parent and sub (this is
called the direct method), or use a blank worksheet. Hint: Year-end is June 30. From July 1
Year 5 purchase date to June 30 Year 6 year-end is one year. (hand in)
 Problem 5-13 part (a) only (293) (Cost Method). Form provided. Depreciation expense is part
of miscellaneous expense. Year-end is December 31; purchase date is July 1, so in Year 2
record one-half years’ worth of amortization of the acquisition differential. (hand in)
 Problem 5-11 part (a) only (290) (Equity Method). No form provided; use the direct method or
a blank worksheet. Also include the Year 6 journal entries that Aaron would have made to
account for its investment in Bondi (hand in)
Hint: the amortization of the acquisition differential for the bonds payable is $1,461 in Year 4,
$3,100 in Year 5, and $3,354 in Year 6. These numbers come from the bond amortization
schedule based on the information given about the bonds. This is not required for our course.
 Problem 5-5 (284) Ignore the list of requirements in the text and instead perform the
calculations for consolidation steps 1 – 6 for Year 3 only.
 Problem 5-12 (291). Part (a) Ignore the valuation of non-controlling interest given as $35,000;
calculate non-controlling interest in the usual way. Ignore the note that the Parent’s share of
the goodwill is $16,364; calculate goodwill in the usual way. Assume that at acquisition Rabb
had accumulated amortization of $12,000.
 Problem 5-15 (295) Part (a) Note, text refers to financial statements being provided on the
following page. The text did not provide the statements. Use the form provided at the end of
the outline. Assume that Brady used the cost method to account for its investment in Partridge.
 Debrief analysis Please provide a brief analysis of your homework submission. This is done
by comparing the solution provided in moodle to your own attempt. Summarize areas you did
well and areas for improvement. Explain what specific area(s) you need to work on and what
areas you felt you understood well. You can provide specific analysis for each question
attempted or provide an overview of the assignment as a whole. This needs to go beyond, "I
did great" or "I did poorly". Answer why you performed the way you did and what are the next
steps to solidify or improve. (Minimum 150 words, maximum 250 words). (hand in)
2019
Certain forms Copyright  2019 McGraw-Hill Ryerson Limited. All rights reserved.
Assignment Problem 5-7
Income Statement Grant Lee Adjustments Consolidated
Sales 900,000 360,000
COGS 340,000 240,000
Gross margin 560,000 120,000
Depreciation expense 30,000 25,000
Other expenses 180,000 56,000
Income tax expense 120,000 16,000

Net income 230,000 23,000

Retained Earnings
Opening 70,000 42,000
Net income 230,000 23,000
Closing 300,000 65,000

Balance sheet
Cash 5,000 18,000
Accounts receivable 185,000 82,000
Inventory 310,000 100,000
Investment in Lee 70,000
Equipment, net 230,000 205,000
Patent, net 2,000

800,000 407,000

Accounts payable 190,000 195,000
Other accrd liabilities 60,000 50,000
Income taxes payable 80,000 72,000

Common stock 170,000 25,000
Retained earnings 300,000 65,000
800,000 407,000
2019
Assignment Problem 5-13
Income Statement Pearl Silver Adjustments Consolidated
4,450,00 1,450,00
Sales 0 0
4,682,00 1,450,00
Total revenues 0 0
2,590,00
Cost of sales 0 490,000
Misc expense 365,000 79,000
Admin. expense 89,000 19,000
Income tax expense 295,000 165,000

1,343,00
Net income 0 697,000

Retained Earnings
3,800,00
Opening 0 890,000
1,343,00
Net income 0 697,000
Dividends 590,000 290,000
4,553,00 1,297,00
Closing 0 0

Balance sheet
Cash 390,000 190,000
Accounts rcbl 290,000
2,450,00
Inventory 0 510,000
3,450,00 3,590,00
Plant & equip 0 0
Accum depr (840,000) (400,000)
3,300,00
Investment in Silver 0

9,040,00 3,890,00
Total assets 0 0

Liabilities 737,000 543,000

2019

3,750,00 2,050,00
Common stock 0 0
4,533,00 1,297,00
Retained earnings 0 0
9,040,00 3,890,00
Total liab & equity 0 0
2019
Extra: Problem 5-15 (altered for cost method)
Income
Statement Brady Partridge Adjustments Consolidated
Sales 10,100,000 5,100,000
COGS 7,022,000 3,030,000
Gross profit 3,078,000 2,070,000
Total income 3,166,000 2,070,000
Depr exp 920,000 402,000
Patent amort exp 120,000
Interest exp 490,000 310,000
Other exp 700,000 870,000
Tax exp 620,000 160,000

Net income 436,000 208,000

Retained
Earnings
Opening 5,982,000 3,421,000
Net income 436,000 208,000
Dividends 300,000 110,000
Closing 6,118,000 3,519,000

Balance sheet
Cash 420,000 620,000
A/R 1,100,000 1,400,000
Inventory 4,800,000 2,000,000
Plant & equip 8,200,000 5,200,000
Patents 720,000
Inv. In P shares 4,320,000

Total assets 18,840,000 9,940,000

Accts payable 3,522,000 1,400,000
Bonds payable 4,100,000 3,000,000

Common stock 5,100,000 2,021,000
RE 6,118,000 3,519,000
Total liab & equity 18,840,000 9,940,000
2019

462 Chapter 5 Notes 2019

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Buad 462 Chapter 5 Notes 2019 Page 1 of 23

CONSOLIDATION SUBSEQUENT TO ACQUISITION DATE

Consolidated Income and Retained Earnings Statements (209-211)

Consolidated Income Statement: A consolidated income statement will be prepared,

Consolidation of a 100-Percent-Owned Subsidiary (218 – 227)

Consolidation of an 80-Percent-Owned Subsidiary ((227 – 238))

 THIS IS THE FIRST DIFFERENCE BETWEEN THE TEXT AND NOTES

Changes to the acquisition differential schedule (similar to Exhibit 5.4)

 Instead we will be using a slightly different schedule called, “acquisition differential

Acquisition differential amortization and impairment schedule

Summary of Steps that we will use in class (not in text):

FVD (Bal) Amort & UAD Balance Amort & RAD

Step 4: we will use the following to calculate BNCI and NCI:

Less Opening R/E (both sub and parent added) (xx)

Abbreviation Summary of above:

Color Coding summary: Highlight colors will be:

Identifiable Net Assets Method (237-238)

Acquisition Differential Assigned to Liabilities (238 – 240)

Intercompany Receivables and Payables (240)

Accts payable 130,000 96,500

Subsidiary Acquired during the Year (240, 241)

Equity Method of Recording (241 – 244)

Analysis and Interpretation of Financial Statements (244 – 246)

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